Sonoma Pharmaceuticals, Inc. — Form 10-Q
Reporting period: Three months ended June 30, 2021 (the first quarter of fiscal 2022); filed August 16, 2021. Financial statements are unaudited. Sonoma develops and sells stabilized hypochlorous acid (HOCl) products for human and animal health and other uses, directly and through partners in 54 countries.
Financial highlights
| Metric | Q1 FY2022 | Q1 FY2021 |
|---|---|---|
| Revenue | $3.684 million | $5.767 million |
| Gross profit / margin | $1.453 million / 39% | $2.255 million / 39% |
| Operating expenses | $2.357 million | $2.920 million |
| Loss from continuing operations | $1.098 million | $0.709 million |
| Net income (loss) | $(1.098) million | $0.240 million |
| Basic and diluted loss per share | $(0.52) | Basic $0.13; diluted $0.13 |
| Operating cash flow | $(1.223) million | $(2.291) million |
- Revenue declined 36% year over year. Human Care revenue was $2.715 million versus $5.377 million; Animal Care revenue rose to $812,000 from $377,000; Service and Royalty revenue was $157,000 versus $13,000.
- By geography, United States revenue was $1.592 million (down 2%), Latin America $565,000 (down 76%), and Europe and Rest of World $1.527 million (down 16%). Management attributed the Latin America drop mainly to lower Invekra orders; the prior-year period included substantial orders under a reduced-price manufacturing arrangement. Lower Brill start-up orders contributed to the Europe and Rest of World decline.
- Gross margin held at 39%. R&D expense fell 82% to $84,000, primarily following closure of the Seattle facility and relocation of R&D to Mexico. SG&A fell 7% to $2.273 million, but increased to 62% of revenue from 42% as sales declined.
- Q1 FY2021 included $949,000 of income from discontinued operations, including a $795,000 gain related to the sale of the Micromed business. This drove prior-year net income despite a continuing-operations loss; the business had no discontinued-operations income in Q1 FY2022.
Balance sheet, liquidity and debt
- Cash and cash equivalents were $2.811 million at June 30, 2021, down from $4.220 million at March 31, 2021. Cash decreased $1.409 million in the quarter.
- Working capital was $6.924 million, down from $8.905 million at March 31. Current assets were $12.157 million and current liabilities $5.233 million; total assets were $14.121 million and total liabilities $9.500 million.
- Operating cash use was $1.223 million. Investing cash use was $49,000, mainly equipment purchases; financing cash use was $209,000, mainly $199,000 of debt principal payments.
- At June 30, the balance sheet showed $1.310 million of PPP debt classified as current and $397,000 of current long-term debt; no long-term PPP balance remained. The $1.310 million PPP loan carries 1% interest, matures April 2022, and forgiveness was still awaiting approval. The company also reported a $3.570 million withholding tax payable.
- Management said additional capital may be needed and that financing may not be available on acceptable terms. The filing states these conditions raise substantial doubt about the company’s ability to continue as a going concern; the financial statements include no adjustments for a possible failure to continue operations.
Outlook, developments and risks
- Under the March 2021 agreement, EMC Pharma received exclusive U.S. rights to manage, market and distribute Sonoma’s prescription dermatology and eye-care products for an initial five-year term. Starting in the quarter ending September 30, 2021, management expected lower product revenue because EMC’s transfer prices would be lower, but anticipated larger operating-cost savings from reduced sales-force and servicing costs and the elimination of rebates, with an overall improvement in financial performance.
- Management expected reduced Invekra orders to continue as that partner transitions to its own manufacturing. Sonoma said remaining overflow orders would be at market prices and higher margin than the prior reduced-price arrangement.
- The company cited COVID-19-related uncertainty, dependence on distributors and major customers, sales and commercialization execution, regulatory approvals, reimbursement and pricing pressure, and the ability to raise capital among its risks. Two customers represented 22% and 15% of Q1 revenue. Management reported no material change to previously disclosed risk factors.
- Management disclosed a substantial Mexico tax exposure relating to intercompany debt, unpaid technical assistance charges and accrued interest; amounts were not due until 2027, and tax professionals were reviewing options.
- On July 30, 2021, after quarter-end, Sonoma entered an at-the-market offering agreement for up to $6 million of common stock. The sales agent’s commission is 3% of gross proceeds, with up to $50,000 of specified expenses reimbursable. The filing also reports new employment agreements for the CEO, CFO and COO effective July 1, 2021.
- Disclosure controls and procedures were deemed ineffective at June 30, 2021 due to material weaknesses, including spreadsheet-control and segregation-of-duties deficiencies, inadequate revenue analysis, and insufficient review of tax consequences of intercompany transactions. Remediation steps were underway, but management said testing was still in progress and weaknesses were not yet considered remediated.
- Ordinary-course legal matters were described as currently insignificant by management, though the filing notes litigation could adversely affect the business. No off-balance-sheet arrangements were reported.
Important facts for investors to verify
- Cash runway, operating cash burn and the company’s ability to obtain additional financing given the stated going-concern uncertainty.
- Status of PPP loan forgiveness and the nature, measurement and timing of the Mexico withholding-tax and intercompany exposures.
- Whether the anticipated EMC Pharma cost savings offset lower transfer-price revenue as the agreement takes effect.
- Invekra’s future order levels and the degree of customer concentration, including the two customers accounting for 37% of quarterly revenue combined.
- Progress and effectiveness testing of the disclosed internal-control remediation measures.
- Any shares sold under the $6 million ATM program and the resulting dilution and cash proceeds.